2022 Q4 Quarterly Market Review – Rising Interest Rates

By Schultz Collins Investment Counsel on January 23, 2023

The year 2022 was marked by economic unrest. From geopolitical events and the war in Ukraine, soaring inflation and increased interest rates, as well as market volatility and fears of a recession, there was sufficient turmoil to cause investor anxiety. During the fourth quarter, markets rebounded some, boosted by the relaxation of China’s zero-Covid policy and stronger economic momentum in the second half of the year than expected, however, many markets ended the year in negative territory. 

Figure 1 

Data provided by Morningstar as of 1/3/2023. For illustrative purposes only. 

The MSCI All Country World Index of global stocks rose 9.88% in the fourth quarter and ended the trailing 12-month period down 17.97%. In US markets, the S&P 500 Index of large company stocks increased 7.56% for the quarter and is down 18.12% over the past 12 months. Small companies in the United States, as measured by the Russell 2000 Index, fared worse during the quarter, up only 6.23% in comparison, and dropped 20.45% over the trailing 12-month period. The Dow Jones US Select Real Estate Investment Trust Index, a benchmark for US real estate performance, was up 4.76% for the quarter and down 25.98% over the previous 12 months.  

International company stocks saw a similar recovery in the fourth quarter. Overseas stocks, as measured by the MSCI Europe, Australasia and Far East Index, rose 17.40% over the past 3 months, and fell 14.02% over the past 12 months. The MSCI Emerging Markets Stock Index was up 9.79% in the quarter, and declined 19.75% over the trailing 12-months.  

Bond holders saw some relief in the fourth quarter. The combined market for government and corporate bonds in the United States, as measured by the US Aggregate Bond Index, was up 1.87% for the quarter and down 13.02% for the trailing 12-month period. The global bond market rose more than the aggregate US bond market in the fourth quarter, up 3.82%, yet dropped further over the past 12 months, down 18.27%. Intermediate-term corporate bonds in the US rose 2.72% in the quarter and fell 9.41% in the last 12 months. 

Figure 2 

Data provided by Morningstar as of 1/3/2023. For illustrative purposes only. 

Interest rates started to decline some in the fourth quarter. The yield on the 10-year Treasury sat at 3.88% on December 31^st, up 2.25% since the beginning of the year. The Federal Reserve pared back its final rate hike in 2022 to a 50 basis points rise vs. a 75 basis points rise, however, the policy rate is expected to continue to increase in 2023.   

Figure 3 

Data provided by Federal Reserve Board as of 1/3/2023. For illustrative purposes only. 

Given the recent increase in interest rates, you may be asking yourself how you should think about rising interest rates. We’ll help you answer that question in the remainder of this quarterly market review.  

In 2022, the Federal Reserve raised interest rates by 4% in response to high inflation. As interest rates rose, bond prices fell, and the bond market was down in 2022. Given the trend in interest rate hikes, some investors may be considering a reduction in their bond exposure. On the other hand, given the higher interest rates, some investors may be considering an increase in their bond exposure. And there are some investors who may consider maintaining their current bond exposure.  

Figure 4 

Data provided by Forbes as of 1/5/2023. For illustrative purposes only. 

To understand what you should consider, let’s walk through an illustrative, hypothetical example of how rising interest rates can affect expected bond returns. Imagine going to buy a $100,000 bond that pays 1% interest. The value of that bond over time is the orange line in Figure 5. It starts out at $100,000 and increases by 1% every year.  

Figure 5 

Data provided by Dimensional Fund Advisor as of 1/5/2023. For illustrative purposes only. 

Now imagine that interest rates rose to 4% immediately after buying that bond. The blue line in Figure 6 shows the value of the bond in this scenario. The rise in interest rates caused an immediate fall in the bond’s value, so the blue line starts out below the orange line.  

However, the higher interest rate environment accelerates the blue line’s recovery to eventually surpasses the orange line. Note that it may take several years for the gains of a higher interest rate environment to overcome the short-term pains of a sharp rise in interest rates.  

Figure 6 

Data provided by Dimensional Fund Advisor as of 1/5/2023. For illustrative purposes only. 

Rising interest rates impact bonds in many ways. On the one hand, longer-term bonds may immediately underperform shorter-term bonds, as the lower interest payments on old bonds become less attractive. On the other hand, higher interest rates may lead to higher expected returns, as interest payments on new bonds rise.  

Markets will quickly try to incorporate all new information on interest rates and inflation, so successfully timing the markets is extremely difficulty.  

Instead, investors should focus on controlling risk. Investors who have bond exposures appropriate for their risk preferences may be more satisfied with their long run investment experience, even after interest rates have risen. The example only illustrated a few things to consider when interest rates rise, but those should not be the only factor in your decisions. If you want to learn more about interest rates and your investments, please contact us.

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